NEED QUICK OPINIONS - Lease Option: how much $$ to principle?

Question

So super important question for you BP! I am thinking to Lease Option my primary residence when i move out of state - how much would you suggest i charge in excess to market rate to go towards the Lease Option purchase price?

for example:

market rate today: $215,000

Market Rent: $1550

My thoughts are to do a 3 year lease option for a final price of $215,000. i would charge an initial option fee of one months rent $1550, rent of $1550, and a per month to principle of $250.

my thoughts are that though they would be paying $1800 per month for a rent normally $1550, after the 3 years they would have the $1550 + $9000 (36 months * $250) for a total of $10,550, or just about 5% down towards the purchase. my thoughts are that way even if they are poor at saving, they at least will have enough down for a conventional or FHA loan, not including the fact that the value of the home will likely be greater than today.

is this unreasonable to ask? is $250 too much? am I being too greedy or am I focusing too much on making sure they will be that much closer to qualifying that i would be making it unbearable?

please let me know your thoughts.

Dave Foster · Answer

@Jacob Chapman, $0!!!!Any amount of principle reduction (purchase price abatement) included in a lease gives that tenant an equitable interest in the real estate. They become an owner with a certain amount of the burdens and benefits of real estate ownership. If anything goes south you could now be foreclosing and not evicting - big difference.Lease options can be awesome ways to get some extra sizzle with your rental. But keep the option separate from the lease. Never let the lease affect the sales price in any way.You can credit the option fee against the price. That's a little less messy. You can also structure a sliding purchase price depending on when option is exercised - again do this in the option not in the lease.Or... since you're wanting to "tie up loose ends" you also may want to take that property with you to OKC and use it as the war chest to leverage your first rentals there. That's where the 1031 exchange comes in. When you're ready to move - or even better, shortly after you move and feel good about your local knowledge you sell the AZ property and 1031 into your first best OKC properties. Defer all tax, consolidate your portfolio, less dollars out of your pocket, release equity for more investing - sounds like a big win to me!

Kerry Baird · Answer

I want to piggyback on what @Dave Foster said regarding the lease and the option. In one of our early deals, we sold a property with a lease option. Only, we did them in a combined fashion. The tenant buyer later defaulted. When we contacted our lawyer to get the property back, he said we’d have to evict AND foreclose. The eviction was fast; the foreclosure...not so much. This was costly and took time to get the property back, and then the tenant had caused damage (of course she did), so we had to renovate the house again. And then put it back on the market to sell. Thankfully, the market was still trending up and we made more selling it the second time than we did the first time around. Ouch.

Dave Foster · Answer

@Jacob Chapman, When I did them I factored in three different profit opportunities for me.1. The option fee2. The monthly rent3. The strike price for the sale.The option fee is a convenience for them. It's their opportunity to guarantee that they can buy that house if they want. So it costs them something. The monthly rent is what I would make renting to anybody. The strike price is what I would be willing to sell that house for at any point in time to anyone.The option fee and the strike price were one agreement that had nothing to do with the rent.The lease and lease deposits were in a second agreement totally independent on the option agreement.It's a sellers market so make it where you can. I only lease optioned nice properties where they were corporate transfers deciding on staying in town after a contract or waiting to sell a home somewhere else. So the option fee was a convenience to them that I could attach some good value to. The strike price became a function of when they would execute. Last one I did in Denver a few years ago appreciation was 8-10% annually so I simply made the option at one price if they executed in 12 months which was retail plus 8%. If they executed at 24 months it was an additional 8% so forth and so on.Yes, perfectly fine to 1031 a lease optioned property. The option payment would be taxed regularly as would the rent. But the 1031 would start with the closing of the sale. Having an executed option and contract in place can be very beneficial if you want to try to get into contract on your purchases prior to the closing of the sale to mitigate the 45 day pressure.

Jacob Chapman · Answer

@Dave Foster Thanks for the advice! So you would suggest a standard rent rate, but have a large up front option fee? Or just ignore that and simply just rent only? Can you do a 1031 exchange off of a lease option?

Dave Foster · Answer

Didn't tag correctly.

Jacob Chapman · Answer

@Jim Pellerin Great question! I am motivated in terms of I want to tie up loose ends in the next 5 months and retain the best profits as possible, but I will not be at the point of "I need it gone" for a while now. In other words, I can wait if needed Thanks for the advice I advance :)

Jim Pellerin · Answer

Are you doing this because you are a motivated seller? By that, I mean, are you having trouble selling your house?